Asset AllocationJuly 31, 2023

Unicorns Hobbled Amid VC Pullbacks

Non-public companies valued at $1 billion and up haven’t sprung back with the stock market.

Reported by Larry Light

In mythology, unicorns have magical powers, from healing sickness to turning water potable.

In finance, their enchantment is fading, owing to over-valuation that lately has crashed. Unlike the flying, one-horned horses of fable, the financial unicorns—private startups worth $1 billion or more—have run up against forces pulling them back to earth.

On paper, venture capital-backed unicorns, many of them tech-tilted companies, are valued at $5 trillion. But their recent problems have sliced that in half, by the estimate of Coatue Management, a technology-oriented investment firm with both private and public holdings. There are “too many unicorns requiring too much capital,” a Coatue research presentation stated.

As initial public offerings and acquisitions have dried up, so has the ability of unicorns to furnish their VC backers with lucrative exits. Or any exits, for that matter: As these unicorns cannot go public or be bought by others, they have a hard time raising new money from now-dubious investors, by Coatue’s assessment.

One problem: The field has become too crowded. A decade ago, when Aileen Lee of Cowboy Ventures coined the term, only 44 unicorns existed. By this year, that has swelled to 1,350, the firm’s report declared.

By Coatue’s measure, the unicorns’ valuation reductions are stark, cascading from their 2021 peaks. Consider three online companies that Coatue has re-valued: Grocery deliverer Instacart is down 69%, online payment processor Stripe is off 47% and Chinese fashion retailer Shein has fallen 34%. Yet, by the values those companies have announced, apparently all three still are unicorns (Instacart, for instance, places its worth at $10 billion).

Part of Coatue’s valuation method is to compare unicorns with similar young companies that have gone public in the last few years. Despite an overall market recovery in 2023 after a calamitous 2022, these new-ish publicly traded outfits still are far down from their maximum levels. Take DoorDash, a competitor to Instacart: It went public in December 2020 and peaked in November 2021.As of last Friday, it was off 63.5% from that high point.

The lack of exits and the reluctance of investors to plug more capital into the unicorns stem from such factors as the administration of President Joe Biden’s push for antitrust enforcement against large tech companies and a credit contraction after Silicon Valley Bank’s collapse.

An S&P Global Market Intelligence research note concluded that the stretch from January to March was “the worst quarter for venture capital and early stage investing in [five] years, with the startup industry struggling to raise funds and stay afloat.” Thus, VC “funding in startups has seen a significant decline, with funding cut in half across North America.”

While in general, technology stocks have recovered from a 2022 dive, the same cannot be said for many fledgling companies. One big reason: Venture investors appear to have gone too far, and many are tapped out. The VC industry has “become bloated to unsustainable levels during the later years of the boom cycle,” a PitchBook analysis found. In 2013, there were 850 active VC firms, a number that by 2023 had ballooned to more than 2,500.

Certainly, some unicorns remain in great shape. Few doubt that artificial intelligence lab OpenAI (said to be valued at $40 billion, and the recipient of a big investment from Microsoft) and Elon Musk’s rocket launcher, SpaceX ($150 billion), have held up valuation-wise and could do well with a public offering.

But for the balance of the class, a dose of magic would sure come in handy these days.